There are typically five financial components to selling your business.
This means there can be five ways to create value when selling your insurance agency.
Cash at close
Stock at close
Ongoing salary
A future earn-out
Commissions
Every offer from a buyer is going to be structured differently.
Understanding each financial component will help you determine the total value of the offer you are getting.
In this post, we will break down the basics of an earn-out.
What is an Earn Out?
An earn-out contract is a part of the asset purchase agreement that allows you to benefit from the future growth of your business (post-acquisition) over a specified time period.
Here are a few key points that help to demonstrate how an earn-out works:
Structure: In an earn-out arrangement, the total purchase price is divided into two parts: an upfront payment (usually a fixed amount in cash or stock) and an additional contingent amount based on achieving specific performance targets or milestones. These performance metrics are typically tied to EBITA growth above a target % or top-line revenue growth above a defined hurdle. The earn-out calculation is defined in the contract to purchase the business where performance metrics are identified.
Timeline: Earn-outs are time-limited arrangements There is a specified period (typically 1-3 years) during which you, as the seller, must meet the agreed-upon performance targets to receive this contingent portion of the purchase price. This timeline is negotiated as part of the acquisition agreement and can be paid out at the end of each year or the end of the full period.
Due Diligence: For an earn-out to work effectively, there must be a high level of trust between the buyer and the seller. The seller needs confidence that the buyer will provide the necessary support and resources to help the business achieve the performance targets outlined in the earn-out agreement. The buyer needs confidence that the seller will exercise integrity and honesty throughout the evaluation.
Negotiation and Clarity: The earn-out terms, including the performance metrics, measurement periods, and payout structure, should be negotiated carefully and clearly in the acquisition agreement. Ambiguities can lead to disputes, so it's essential to have a well-drafted contract that aligns with your go-forward goals.
Integrations: Earn-outs require integrating the seller’s business into the buyer's operations. The two parties need to work collaboratively to ensure a smooth transition and alignment of strategies to meet the performance targets.
It is critical for both buyers and sellers to approach earn-outs with a clear understanding of expectations and a commitment to effective communication and collaboration. Legal and financial advisors can be crucial in structuring and negotiating earn-out agreements.
Legacy Advisors is the only M&A advisor comprised of previous agency owners dedicated solely to sell-side insurance deals.
Schedule a call with us if you are curious about what a sale could look like for you. We can answer your questions, advise on market trends, and discuss ranges for what a buyer might pay for your business.
Comments